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    1. 1. 2 Thinking Like an Economist
    2. 2. Thinking Like an Economist <ul><li>Every field of study has its own terminology </li></ul><ul><ul><li>Mathematics </li></ul></ul><ul><ul><ul><li>integrals  axioms  vector spaces </li></ul></ul></ul><ul><ul><li>Psychology </li></ul></ul><ul><ul><ul><li>ego  id  cognitive dissonance </li></ul></ul></ul><ul><ul><li>Law </li></ul></ul><ul><ul><ul><li>promissory  estoppel  torts  venues </li></ul></ul></ul><ul><ul><li>Economics </li></ul></ul><ul><ul><ul><li>supply  opportunity cost  elasticity  consumer surplus  demand  comparative advantage  deadweight loss </li></ul></ul></ul>
    3. 3. Thinking Like an Economist <ul><li>Economics trains you to. . . . </li></ul><ul><ul><li>Think in terms of alternatives. </li></ul></ul><ul><ul><li>Evaluate the cost of individual and social choices. </li></ul></ul><ul><ul><li>Examine and understand how certain events and issues are related. </li></ul></ul>
    4. 4. THE ECONOMIST AS A SCIENTIST <ul><li>The economic way of thinking . . . </li></ul><ul><ul><li>Involves thinking analytically and objectively. </li></ul></ul><ul><ul><li>Makes use of the scientific method. </li></ul></ul>
    5. 5. The Scientific Method: Observation, Theory, and More Observation <ul><li>Uses abstract models to help explain how a complex, real world operates. </li></ul><ul><li>Develops theories, collects, and analyzes data to evaluate the theories. </li></ul>
    6. 6. The Role of Assumptions <ul><li>Economists make assumptions in order to make the world easier to understand. </li></ul><ul><li>The art in scientific thinking is deciding which assumptions to make. </li></ul><ul><li>Economists use different assumptions to answer different questions. </li></ul>
    7. 7. Economic Models <ul><li>Economists use models to simplify reality in order to improve our understanding of the world </li></ul><ul><li>Two of the most basic economic models include: </li></ul><ul><ul><li>The Circular Flow Diagram </li></ul></ul><ul><ul><li>The Production Possibilities Frontier </li></ul></ul>
    8. 8. Our First Model: The Circular-Flow Diagram <ul><li>The circular-flow diagram is a visual model of the economy that shows how dollars flow through markets among households and firms. </li></ul>
    9. 9. Figure 1 The Circular Flow Copyright © 2004 South-Western Spending Revenue Income = Flow of inputs and outputs = Flow of dollars Goods and services bought Goods and services sold Labor, land, and capital Factors of production Wages, rent, and profit FIRMS <ul><li>Produce and sell </li></ul>goods and services <ul><li>Hire and use factors </li></ul>of production <ul><li>Buy and consume </li></ul>goods and services <ul><li>Own and sell factors </li></ul>of production HOUSEHOLDS <ul><li>Households sell </li></ul><ul><li>Firms buy </li></ul>MARKETS FOR FACTORS OF PRODUCTION <ul><li>Firms sell </li></ul><ul><li>Households buy </li></ul>MARKETS FOR GOODS AND SERVICES
    10. 10. Our First Model: The Circular-Flow Diagram <ul><li>Firms </li></ul><ul><ul><li>Produce and sell goods and services </li></ul></ul><ul><ul><li>Hire and use factors of production </li></ul></ul><ul><li>Households </li></ul><ul><ul><li>Buy and consume goods and services </li></ul></ul><ul><ul><li>Own and sell factors of production </li></ul></ul>
    11. 11. Our First Model: The Circular-Flow Diagram <ul><li>Markets for Goods and Services </li></ul><ul><ul><li>Firms sell </li></ul></ul><ul><ul><li>Households buy </li></ul></ul><ul><li>Markets for Factors of Production </li></ul><ul><ul><li>Households sell </li></ul></ul><ul><ul><li>Firms buy </li></ul></ul>
    12. 12. Our First Model: The Circular-Flow Diagram <ul><li>Factors of Production </li></ul><ul><ul><li>Inputs used to produce goods and services </li></ul></ul><ul><ul><li>Land, labor, and capital </li></ul></ul>
    13. 13. Our Second Model: The Production Possibilities Frontier <ul><li>The production possibilities frontier is a graph that shows the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. </li></ul>
    14. 14. Figure 2 The Production Possibilities Frontier Copyright©2003 Southwestern/Thomson Learning Quantity of Cars Produced 0 3,000 1,000 Quantity of Computers Produced Production possibilities frontier A B C 2,200 600 1,000 300 700 2,000 D
    15. 15. Our Second Model: The Production Possibilities Frontier <ul><li>Concepts Illustrated by the Production Possibilities Frontier </li></ul><ul><ul><li>Efficiency </li></ul></ul><ul><ul><li>Tradeoffs </li></ul></ul><ul><ul><li>Opportunity Cost </li></ul></ul><ul><ul><li>Economic Growth </li></ul></ul>
    16. 16. Figure 3 A Shift in the Production Possibilities Frontier Copyright © 2004 South-Western Quantity of Cars Produced 0 Quantity of Computers Produced E 2,000 700 2,100 750 4,000 3,000 1,000 A
    17. 17. Microeconomics and Macroeconomics <ul><li>Microeconomics focuses on the individual parts of the economy. </li></ul><ul><ul><li>How households and firms make decisions and how they interact in specific markets </li></ul></ul><ul><li>Macroeconomics looks at the economy as a whole. </li></ul><ul><ul><li>Economy-wide phenomena, including inflation, unemployment, and economic growth </li></ul></ul>
    18. 18. THE ECONOMIST AS POLICY ADVISOR <ul><li>When economists are trying to explain the world, they are scientists. </li></ul><ul><li>When economists are trying to change the world, they are policy advisor. </li></ul>
    19. 19. POSITIVE VERSUS NORMATIVE ANALYSIS <ul><li>Positive statements are statements that attempt to describe the world as it is. </li></ul><ul><ul><li>Called descriptive analysis </li></ul></ul><ul><li>Normative statements are statements about how the world should be. </li></ul><ul><ul><li>Called prescriptive analysis </li></ul></ul>
    20. 20. <ul><li>Positive or Normative Statements? </li></ul><ul><ul><li>An increase in the minimum wage will cause a decrease in employment among the least-skilled. </li></ul></ul><ul><ul><li>POSITIVE </li></ul></ul><ul><ul><li>Higher federal budget deficits will cause interest rates to increase. </li></ul></ul><ul><ul><li>POSITIVE </li></ul></ul>POSITIVE VERSUS NORMATIVE ANALYSIS ? ? ?
    21. 21. <ul><li>Positive or Normative Statements? </li></ul><ul><ul><li>The income gains from a higher minimum wage are worth more than any slight reductions in employment. </li></ul></ul><ul><ul><li>NORMATIVE </li></ul></ul><ul><ul><li>State governments should be allowed to collect from tobacco companies the costs of treating smoking-related illnesses among the poor. </li></ul></ul><ul><ul><li>NORMATIVE </li></ul></ul>POSITIVE VERSUS NORMATIVE ANALYSIS ? ? ?
    22. 22. Economists in Washington <ul><li>. . . serve as advisers in the policymaking process of the three branches of government: </li></ul><ul><ul><li>Legislative </li></ul></ul><ul><ul><li>Executive </li></ul></ul><ul><ul><li>Judicial </li></ul></ul>
    23. 23. Economists in Washington <ul><li>Some government agencies that collect economic data and make economic policy: </li></ul><ul><ul><li>Department of Commerce </li></ul></ul><ul><ul><ul><li>http://www.commerce. gov </li></ul></ul></ul><ul><ul><li>Bureau of Labor Statistics </li></ul></ul><ul><ul><ul><li>http://www.bls. gov </li></ul></ul></ul><ul><ul><li>Congressional Budget Office </li></ul></ul><ul><ul><ul><li>http://www.cbo. gov </li></ul></ul></ul><ul><ul><li>Federal Reserve Board </li></ul></ul><ul><ul><ul><li>http://www.federalreserve. gov </li></ul></ul></ul>
    24. 24. WHY ECONOMISTS DISAGREE <ul><li>They may disagree about the validity of alternative positive theories about how the world works. </li></ul><ul><li>They may have different values and, therefore, different normative views about what policy should try to accomplish. </li></ul>
    25. 25. Table 2 Ten Propositions about Which Most Economists Agree Copyright © 2004 South-Western
    26. 26. Summary <ul><li>Economists try to address their subjects with a scientist’s objectivity. </li></ul><ul><ul><li>They make appropriate assumptions and build simplified models in order to understand the world around them. </li></ul></ul><ul><ul><li>Two simple economic models are the circular-flow diagram and the production possibilities frontier. </li></ul></ul>
    27. 27. Summary <ul><li>Economics is divided into two subfields: </li></ul><ul><ul><li>Microeconomists study decisionmaking by households and firms in the marketplace. </li></ul></ul><ul><ul><li>Macroeconomists study the forces and trends that affect the economy as a whole </li></ul></ul>
    28. 28. Summary <ul><li>A positive statement is an assertion about how the world is. </li></ul><ul><li>A normative statement is an assertion about how the world ought to be. </li></ul><ul><li>When economists make normative statements, they are acting more as policy advisors than scientists. </li></ul>
    29. 29. Summary <ul><li>Economists who advise policymakers offer conflicting advice either because of differences in scientific judgments or because of differences in values. </li></ul><ul><li>At other times, economists are united in the advice they offer, but policymakers may choose to ignore it. </li></ul>